“We’re doing him a huge favor! And do you realize how extreme this is to go from no debt to good old fashioned American debt? That’s the way to do it. Plus, I’ve been envisioning someone else paying for this thing the entire time.” – It’s Always Sunny in Philadelphia
This was before a hurricane in Houston, almost all the shelves were bare. Not the last hurricane. So, after the Apocalypse? You can still get food from Weight Watchers®.
The Cold Equations is a short story (you can find it here and read for free (LINK) on .pdf so you should read it today) that I remember reading as a young lad up on Wilder Mountain. I think I read it in an old, moldy paperback from the Junior High library on a long bus trip.
The story sets up a moral choice, and a tough one. But don’t we face those every day? Don’t we look at the short term, the now, and not realize there are vast implications for our future actions? Like if I eat all the PEZ® now, there’ll be none left for later?
I’m guilty of not looking at the big picture, too.
When I think about personal finance, most of the time what I’m thinking about are smaller strategies: what mix of bonds and stocks should I have? Index funds or mutual funds? Managed funds? How much of my net worth in real estate? How much car should I buy? Do I really need the signed Battlestar Galactica helmet? (Answer: YES!!!!)
And these are meaningful questions, and really have been the most meaningful questions for essentially all of my life: these were the right questions to ask. And, even though the economy has had ups and downs, for the most part, we’re like ships in pretty calm water. Storm from time to time? Sure. But we’ve never see a hurricane.
Outside of technology (which I’ve discussed here (LINK) and which I will likely revisit soon) probably the two biggest factors in determining your personal financial future are government debt, which we’ll discuss in this post, and future payments that governments must make, which we’ll discuss next Wednesday. I was originally going to discuss it today, but like government debt, this post got bigger faster than I was expecting.
Government Debt and Why 1973 is Important:
I’m picking a start date for my look into government debt as 1973. In my opinion 1973 was a pretty big year for debt. Before 1971, if a country, say, France, had a $100,000,000 in dollars, they could back up the semi and trade those dollars for gold at $35 per ounce.
This really happened. France decided that they had a lot of dollars, but they decided that they liked gold even more. So, like a kid at the arcade with 5,000 Skee-Ball® tickets, they brought all of their dollars up to the counter and asked for gold. And a gummy eraser. And a set of the glasses with the nose and fake mustache.
Nixon decided he liked his gold more than he liked France, so put out an emergency order that the Skee-Ball© window was closed, and that France could keep their tickets. This set in a chain of events that determined just how many dollars could even exist . . . .
In 1972, Nixon ordered that the dollar be devalued from $35 per ounce of gold to $38 per ounce of gold. I’m not sure anyone listened because we’d stopped converting dollars to gold. And, in 1973 the decision was made to allow normal American citizens to own gold, something that President Roosevelt had made illegal in 1933. The gold/dollar link was severed, so the US could print as many dollars as they chose.
(Roosevelt had confiscated all of the gold coins and bullion in the hands of Americans in 1933 at the price of $20.67 per ounce and made it illegal for Americans to own gold. After he had all the gold? He said it was worth $35 per ounce. Nifty way to make an instant 70% profit, if you’re the government. If you or I did that, they would just compare us unfavorably to Bernie Madoff. And that’s just the hair!)
So, I picked 1973, because that approximates the date when the US dollar was completely free of any constraints put on it by a gold standard. And also, coincidently when Alice Cooper released his classic album Billion Dollar Babies. Or is it really a coincidence? Regardless, my choice of 1973 as a starting point isn’t arbitrary.
A fine album – you should buy six or so. Album Picture via Wikimedia – © believed to be with Warner Music.
DANGER: FALLING DOLLARS AND GRAPHS AHEAD
In the graph below, I’ve listed the Debt of the United States over the years since 1973. I first converted the annual figures into 2017 dollars using magic the Bureau of Labor Statistics website, so we don’t have to worry about pesky inflation in this graph. H/T to The Balance (LINK) for pointing to all the appropriate websites for the data.
When I first started inputting the data, I was surprised at how familiar the shape of the curve of the debt was – and when I tried a fit of the data to an exponential curve it matched very nicely. You can see it on the graph. The exponential curve is a pretty standard formulation. I’m not going to get all mathy, but the R2 =0.97 shows that a large amount of the variation you’d expect to see is explained by the curve that’s fit to it. An R2 =1.0 is perfect. Thanks, Excel®! More on the curve fit later.
The dashed line represents the ratio of the national debt (how much the US owes as a country) divided by the Gross Domestic Product (how much the country produces in a year, both goods and services). It uses the right side scale, so you can see that now the national debt is more money than all the goods and services the United States produces in a year are worth.
Hmm. Oddly, Japan leads the list of countries that have a high debt to GDP ratio, primarily because no matter what the government does, the citizens just won’t take on debt, so government takes it on for them, in order to fund more comic books, vending machines, and seven-eyed fish.
Perennial economic basketcases Greece, Lebanon, and Italy have higher debt to GDP ratios than the US, but the United States is 12th out of 100 or so on a list where you really don’t want to be at the top. Admittedly, most of the countries on the bottom of the list don’t actually use money, but rather trade goats for transistor radios and nine-volt batteries so they can listen to 1970’s disco music, which is all the rage now.
But let’s get back to the overall debt. If it is a good fit for the past, I can try to use that same curve to project 10 or 20 years into the future, as I did in the graph below:
If the projection holds, in 2027 the debt will be above $30 Trillion dollars. That’s $30,000,000,000,000. Some people work a whole year and don’t make that much money! And in 2037, the debt will be a little higher at $55 trillion dollars. But those are 2017 dollars, and we live in world where inflation exists. Here’s that graph:
This graph shows we’ll be facing a debt of $55 TRILLION dollars in ten years, and a tidy $135 TRILLION in twenty years.
For grins, I deleted the last 10 years of data, back to 2006, from the projection from the inflation adjusted numbers. Result? It projected the current level of US debt almost exactly. That equation seems pretty accurate: it’s good at predicting the future.
But when I deleted 10 years’ worth of data from the graph where inflation exists? Yikes! It would have projected a current debt of about $28 trillion versus the $20-ish trillion we’re at right now.
The last ten years have produced inflation that is very low, and interest rates that are at all time historic lows (like all of recorded history low). Both the low inflation and low interest rates have acted to keep the debt much lower than it would normally be. This tells me our debt is very sensitive to inflationary swings (as a first year economics student would figure out and give me a resounding “duh” after thwaping me in the forehead). The ultimate rate of inflation will eventually determine the final shape of the debt’s growth, but we can get to the right range with these estimates.
The Cold Equations don’t lie.
I don’t know about you, but these numbers seem . . . impossibly large. And large in such a fashion that I can’t really see how the system can work. Ben Stein’s dad was famous for saying, “If something can’t continue forever, it won’t.” Interest on that $55 trillion in ten years or so at 5% would be 70% of today’s entire federal budget, for just one year.
This is Ben Stein. Anyone, anyone feel like getting me a beer?
The interesting thing to me is that everyone thinks that there is a choice involved, and that every aspect of the current system in the United States isn’t baked into that equation. But I tested the equation with data from before the housing crash. With data from before Obama. Hate to tell everyone, but we could have elected John McCain or a bowl of quivering strawberry Jell-O® (but I repeat myself) as president for the last eight years and we would be in exactly the same place. It’s not parties, it’s not individuals. It’s the system.
And what are the consequences of trying to stop?
$1.1 trillion was added to the debt in the government fiscal year ending in 2016. This amounted to around 5% of US GDP. US GDP grew by less than 2% that year. Remove the deficit? The US economy shrinks by 3% in that year.
The “Great Recession” saw the economy contract 5.1%.
So, yes, addiction to government debt is bad. The only thing keeping the country out of recession is adding more debt. But the Cold Equations indicate that exponential growth can’t continue forever.
The Part Where Wilder Answers His Own Question
So, why does this continue now? Why doesn’t somebody jump out in front of the speeding train and yell, “Stop!” (I think I answered my own question there.)
It’s convenient. The United States creates dollars out of either paper or electrons, and then ships them halfway across the world to buy something real, like a car, underwear for Johnny Depp, or a barrel of oil. They take our made-up dollars as payment, and ship us the stuff. Then they take the dollars and recycle them into our system and buy the debt through Treasury Notes and Bills. If that’s not a tax, I’m not sure what is. It’s really an awesome deal if you’re the United States.
Eventually someone will create a currency or mechanism to compete with the dollar. China is desperately trying (LINK) having created a mechanism to trade oil not in terms of dollars, but in terms of gold.
Will that system take down the dollar? Likely not. The sheer size and psychological trust the dollar has accumulated over the past hundred and fifty years won’t go away with just one alternative Afghan (the people not the blanket) herdsmen trade actual dollar bills. In Zimbabwe when they turned their currency into the equivalent of a mathematical joke, they traded US dollars to actually buy stuff. And inertia plays a big part. You don’t tear down Rome in one day, week, or month. And, as the Romans showed (LINK) a strong army goes a long, long way to having whatever you say is money be accepted.
The second thing that keeps this system going:
It’s that the system has evolved to grow continually. Jerry Pournelle (who may have been the architect that brought down the entire Soviet Union while writing entertaining science fiction), (1933-2017) described it well in his Iron Law:
Pournelle’s Iron Law of Bureaucracy states that in any bureaucratic organization there will be two kinds of people”:
First, there will be those who are devoted to the goals of the organization. Examples are dedicated classroom teachers in an educational bureaucracy, many of the engineers and launch technicians and scientists at NASA, even some agricultural scientists and advisors in the former Soviet Union collective farming administration.
Secondly, there will be those dedicated to the organization itself. Examples are many of the administrators in the education system, many professors of education, many teachers’ union officials, much of the NASA headquarters staff, etc.
The Iron Law states that in every case the second group will gain and keep control of the organization. It will write the rules, and control promotions within the organization.
This is why NASA can’t launch spaceships, the Department of Education doesn’t teach, and the Department of Energy doesn’t produce power. It’s not that these bureaucrats are bad people, they’re simply focused on personal preservation – they want to have a job until they retire, and enough petty power to make them feel that they’re important. The best way to ensure that is to surround themselves with a staff of fifty. And all of this is in harmony with the equation.
If you notice, both sides pick things to fund, and both sides will defend the other side’s projects to the death. Republicans complain about Obamacare, and then add more funding. Democrats complain about the military, and then add more funding. Each side is careful to preserve the one thing that Washington is good at . . . spending.
What’s the favorite baby in Washington? Billion Dollar Babies!
But I feel that the Cold Equations will point to a place where this cannot last. And when you violate the Equations? Your choices dwindle . . . to zero.